Price transparency is an enormous benefit to consumers in retail markets. Consumers who make the effort to shop around often discover drug prices can vary from one pharmacy to the next. Retail drug prices are mostly transparent; patients generally encounter few problems when calling a pharmacy to ask what a given drug costs on their health plan. However, with the possible exception of buying an automobile, wholesale price transparency provides little benefit to consumers. The reason price transparency serves almost no purpose for consumers in wholesale markets is because consumers don’t buy from wholesale markets!

In wholesale markets, wholesale prices are often negotiated among parties with the details considered proprietary. A wholesale vendor may have a wholesale price for which all retail vendors qualify. But the ability to secure lower wholesale prices through volume discounts is often considered a competitive advantage of a volume purchaser like a big box store. More importantly, just because I don’t know the price Home Depot paid for a stick of lumber does not mean I don’t benefit from the negotiated price breaks that it passed down to its consumers.

Drug makers have pilloried in the press lately for the high prices charged for some of their newer drugs. Politicians have taken notice, including Hillary Clinton, Bernie Sanders — and even Donald Trump. Some drug makers and pharmacy trade groups have tried to pass off some of the blame for high prices by claiming drug plan administrators are jacking up the price consumers pay for drugs (or withholding rebates from plan sponsors). Some of these groups are calling on states to force pharmacy benefit managers (PBMs) to reveal their wholesale prices to prove they are not inflating what consumers and employer pay for drugs. Economists at the U.S. Federal Trade Commission (FTC) and some actuarial consulting firms are understandably skeptical of this claim. The FTC is concerned that mandating price disclosure will remove a bargaining tool used by some firms to compete with others. The FTC also worries the loss of proprietary pricing information could reduce aggressive bargaining or potentially encourage price collusion among manufacturers.

As is common in most other wholesale markets, wholesale drug prices also vary from one purchaser to the next. For many drug makers, wholesale prices are merely “list prices,” sort of like the sticker price on new cars. The manufacturers of brand-name drugs routinely provide discounts off list price in the form of rebates that lower the final cost from 20 percent to 30 percent, on average. When a consumer covered by a drug plan walks into a pharmacy, the prices they (or their health plan sponsor) pays has been negotiated on their behalf by PBMs. PBMs must also compete for the business of health plan sponsors (insurers and employers).

It is ultimately up to plan sponsors to decide whether they want to capture rebates or allow their plan administrators to profit from each claim adjudicated. Plan sponsors are free to negotiate whichever method suits them — and PBMs generally yield to the preferences of their clients. The two most common pricing methods drug plans use are Pass-through pricing and Spread-pricing. With pass-through pricing, PBMs agree to surrender all or part of manufacturers’ drug rebates to their plan sponsor in return for a higher negotiated management fee. With spread-pricing some employer plan sponsors prefer to allow drug plan administrators to earn a small profit on each drug reimbursed and retain some of the rebates in return for lower management fees.

According to a 2015 report, about three-fourths of employer plans share in the rebates negotiated by PBMs:
• More than one-fourth (28 percent) received the entire rebate.
• More than one-in-five (22 percent) received a flat fee per script (worth about $24).
• About 12 percent received a share of the rebate with a guaranteed minimum.
• About 12 percent received a share of the rebate with no guaranteed minimum.

The bulk of manufacturers’ rebates are ultimately passed on to employers, workers and consumers in the form of lower retail prices, lower management fees or lower premiums. Yet, some politicians and political operatives believe forcing drug plan managers to disclose the wholesale drug prices they pay would somehow magically lower consumer prices. This is misguided and is an attempt to move the discussion away from why some drugs are costly: manufactures of patented medications have significant pricing power and new drugs are often an order of magnitude more expensive than older drugs.

Comments (8)

Wholesale drug price disclosure is barking up the wrong tree. Profit margins earned on brand name drugs by wholesalers, PBM’s and retail drug stores are surprisingly low. The real profit margin opportunity is on generic drugs which account for over 85% of all prescriptions these days but only 28% of the dollars spent on drugs. Of course, that could mean buying a drug for five cents a pill and selling it for a quarter but that still only equates to $7.50 for a 30 day supply. That’s not going to break the bank. The big bucks in terms of drug spending are in the specialty drugs and the brand name drugs but the percentage profit margin is comparatively modest on both.

Yea, but for some reason drug makers and pharmacies believe forcing transparency would somehow benefit drug makers and pharmacies. The FTC doesn’t agree. As John Graham has pointed out in other posts, most wholesale buyers don’t tell their retail customers what they paid for a given item. I’ve always heard Walmart earns about $0.03 cents per sales dollar in gross margin, while Whole Foods earns 10 times that. But knowing that fact doesn’t really help me. Comparison shopping for retail prices is what helps me get a better deal. The only market where knowing the wholesale price benefits retail customers is markets like automobiles where the price high and is negotiated.

Devon – For the trailing twelve month period, Wal-Mart’s gross margin was 25.1% while Whole Foods’ was 34.8%. Net after tax profit margin was 3.0% for WMT and 3.3% for WFM.

Retail pharmacy is a strange business in several ways. First, even Wal-Mart doesn’t have any more leverage with drug wholesalers than an independent mom and pop drug store has. They all buy their brand name drugs from one of the three big drug wholesalers – Amerisource Bergen, Cardinal Health or McKesson. The big guys can buy generics direct from the manufacturer, however, and buying power matters a huge amount there. The normal gross margin on a brand name drug for a retail pharmacy is about 5%. The wholesaler’s margin is also tiny by the way.

For the major drug retail chains like Walgreens and CVS, the pharmacy is their core business. It accounts for around 65% of sales for the typical chain drug store. By contrast, it is a very small percentage of sales for supermarkets, discount department stores and wholesale clubs like Costco, Sam’s and BJ’s. As a result, those stores don’t need to make money on their pharmacy. It can be a loss leader and part of being a full service store. When I covered the wholesale clubs ten years ago, Costco, for example, would not allow itself to make more than a 15% gross margin on any item it sold in the store. Indeed, its net income was roughly equal to its club membership fees and it basically broke even on the actual merchandise it sold after factoring in store and corporate overhead.

That all said, several years ago, I called four local pharmacies to get cash prices for the generic drugs I took at the time. Two were chain drug stores, one was a supermarket and one was a wholesale club. The biggest spread I found was for the cholesterol lowering generic drug, Simvastatin. The local supermarket’s cash price was $550 for a 90 day supply. Costco’s price was $10 or a 55 to 1 spread! Profit margins on generics can be enormous and pricing can be quite arbitrary but thanks to apps like GoodRx, price discovery is now a snap.

John – Simvastatin is a Tier 1 drug on my Part D insurer’s formulary which means the patient copay for a 90 day supply is zero. Their copay for for a 90 day supply of a Tier 2 drug is $5.00. However, when you get to Tier 3, they charge $100 or the full cost of the drug if that is less than $100. Two of my drugs are Tier 3 and I found that the cash price at Costco is significantly less than the insurer’s full retail price. The weird thing is, though, that I can buy the drugs at Costco, run them through the insurer and I still only have to pay Costco its low cash price. The combined savings from doing it that way amounts to roughly $100 per quarter for the two drugs.

Thanks for making me aware of the GoodRx app. I made a relative aware of it when I visited last week.

Ok Barry, I was only off Walmart’s gross margin by a factor of 7 — which is especially embarrassing since I could have pulled up the figures you cite on Google in about 30 seconds. (But knowing Walmart has a bigger gross margin doesn’t boost my bargaining power. Although I am surprised Whole Foods is not much higher than Walmart)

Until the 1950’s, there was no such thing as an MSRP sticker on cars when Congress legislated the requirement. Before that, the dealer had all the information and the customer had none. Some price information is important and some isn’t. In the case of drugs, wholesale prices aren’t important but retail prices are and they can be easily ascertained and compared among pharmacies. Individual bargaining ability is irrelevant. That’s not the case with cars even today except with a few dealers that implemented no haggle pricing.

Yes, I believe cars are the exception to the rule. Any big ticket items when consumers negotiate the final price would likely fall into that category. But even then, the retail prices other consumers pay is more important that what retailers acquired the item for.

I’m thoroughly in favor of price transparency in health care. But the transparency that is important are the retail prices consumers pay — not the wholesale prices retailers pay their wholesale suppliers.

The FTC believes mandatory disclosure of wholesale prices could result in manufacturers colluding on price of not bargaining as aggressively knowing they may have to extend the deal other parties. That is already a problem given that Medicaid is already guaranteed the lowest price.